Unlike traditional fiat currency (USD), Bitcoin is not printed or backed by a central bank. These are generated through a process called Bitcoin mining, where computers with high powered hardware are synchronized on a distributed network and use a complex mathematical formula to produce this virtual currency. This process can take hours or even days to produce Bitcoin.
Bitcoin surged in prices towards the second half of the 2010s. Although, many people are still not aware of Bitcoin tax regulations and Bitcoin tax rates. One of the factors for the surge in Bitcoin prices was the misconception that it wasn’t regulated and could be used for transactions to avoid tax obligations. With this, government agencies realized that more black marketers were making transactions to purchase and sell illegal goods.
The United States government has acknowledged the importance of cryptocurrency and is on the same page with the Internal Revenue Service (IRS) to clear up the misconceptions surrounding Bitcoin tax rates and regulations. The IRS has officially stated that Bitcoin or any other cryptocurrency should be treated as an asset or property for the purpose of crypto tax.
What is the IRS Stance on Bitcoin Tax Rates?
When treating Bitcoin as an asset the tax implications will be the same as on any property such as stocks, bonds and real estate. The IRS has mandated that all Bitcoin transactions should be reported when filing your tax returns, regardless of the value. It is the responsibility of the taxpayer to maintain a record of Bitcoin in their possession along with the Bitcoin purchased, sold, invested and transacted for goods and services.
What are the Activities that are Taxable Events?
The following activities are considered to be taxable events according to the IRS which are listed as follows.
- Selling Bitcoin, purchased from another trader, to a third party.
- Selling Bitcoin which were mined, to a third party.
- Using Bitcoin, purchased from another trader, to buy goods or services.
- Using mined Bitcoin to purchase goods or services.
What are Short-term and Long-term Capital Gains?
Due to all cryptocurrency being classified as assets, let’s say that you were to purchase groceries from a supermarket using Bitcoin. You will incur a capital gains tax which will either be, long term or short term based on how long you have held the Bitcoin for. The 2 main taxable gains are listed below.
- Short-term Capital Gains
When Bitcoin is held for a duration of less than a year before trading or selling, a short-term capital gains tax will be applied.
- Long-term Capital Gains
When Bitcoin is held for a duration of more than a year, a long-term capital gains tax will be applied which comes with different Bitcoin Tax Rate brackets.
What are the Bitcoin Tax Rates on Capital Gains?
In the United States, if you have incurred a long-term capital gains tax, there are different Bitcoin tax rates depending on the income of the individual which are listed below.
- 0% for taxpayers in the 10% to 15% ordinary income tax rate bracket.
- 15% for taxpayers in the 25% to 35% tax bracket.
- 20% for taxpayers in the 39.6% tax bracket.
With these Bitcoin tax rates in mind, if the taxpayer has held Bitcoin for more than a year, they will end up paying taxes at a rate lower than the ordinary income tax rate. The drawback to this is, tax deductions on long-term capital losses that a taxpayer can claim are limited. Their capital losses are limited to the total capital gains of upto 3000 dollars of ordinary income made in a year.
Depending on the nature of the Bitcoin dealing, keep in mind the following situations when going about your tax preparations.
- If Bitcoin is received as payment in exchange for providing goods or services, the holding period of the Bitcoin will not matter. It is to be taxed and reported as ordinary income. The Bitcoin tax rate on Federal tax will range between 10% to 39.6% and on top of this, there might be state income taxes to be paid as well.
- If Bitcoin is received from the process of mining, it is to be treated as ordinary income. Along with a self-employment tax to be paid on the receipts.
- If Bitcoin or cryptocurrency is received through exercises such as hard forks or airdrops, it is to be treated as ordinary income.
- If Bitcoin is bought for investment purposes and sold at a profit, it will depend on the holding period. If held for less than a year, net receipts are to be treated as ordinary income. If held for more than a year, it is treated as a capital gain and could attract a 3.8% tax on net investment income.
Tax Softwares to Use to Calculate Bitcoin Tax Rates
Cointracker is a Bitcoin tax rate calculating and reporting software. Their interface allows a trader to import all their crypto data and then displays the history of each Bitcoin trade in detail. It also has some useful tools such as performance tracker that tracks and manages a trader’s Bitcoin investments and the progress of its performance over time.
Zenledger is a full fledged Bitcoin tax accounting software that supports all major exchanges, cryptocurrencies and fiat currencies. It can automatically fill a trader’s tax forms such as FinCen114, FBAR, Form 1040, Schedule D and Form 8949.
Using a Bitcoin tax calculating software can drastically reduce the chance of errors in your tax report and help you stay clear from the hands of the IRS.